The Swiss National Bank’s (SNB) provision of funding to facilitate the takeover of Credit Suisse by UBS and the news that several central banks are offering daily US dollar liquidity highlights the authorities’ crucial role in easing liquidity pressures on European banks amid market stress despite tight regulatory requirements around liquidity risk, Fitch Ratings says.
Rapid deposit outflows from Credit Suisse, which ultimately resulted in the acquisition by UBS, show how quickly liquidity problems can hit banks. Market volatility will make it harder for banks with perceived weaknesses and reliance on less stable funding sources to maintain strong liquidity in the absence of a strong backstop from the authorities.
Concern about interest rate risk in securities portfolios has been one trigger of recent deposit outflows from some US banks. We believe risks from unrealised losses in securities portfolios are small for European banks.
Large EU banks’ securities portfolios accounted for only 11% of total assets, on average, at end-3Q22, compared with about 25% for the entire US banking sector at end-2022. Unrealised losses on government bonds held at amortised cost have increased but banks hold material cash with central banks. We do not expect losses to be realised if the securities are used as collateral for secured funding transactions, including with the central banks.
Many western European banks hedge interest-rate risk, limiting the impact of unrealised losses in securities portfolios as interest rates rise. Regulatory monitoring of interest-rate risk, including limits on capital sensitivity to yield curve shifts, has also limited banks’ ability to take on excessive duration risk.
Nevertheless, higher interest rates are pushing up funding costs, while market volatility has put liquidity in the spotlight. Liquidity risk for European banks is limited by tight regulatory requirements that are broadly common across the EU, UK and Switzerland.
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In addition, most banks are largely funded from granular retail deposit bases, and are not highly reliant on large single-name depositors or individual corporate sectors. This is in contrast to some of the banks that recently failed in the US, which were highly reliant on concentrated deposit franchises. However, a rapid loss in market confidence could quickly erode liquidity buffers.
Banks with larger proportions of corporate deposits or deposits not covered by deposit guarantee schemes, including deposits from wealth management clients, could have greater deposit volatility. Some banks mitigate the risk by attracting time deposits that cannot be terminated early by the depositor.
European banks with large current account franchises have kept pass-through rates low. However, as rates continue to rise, we expect banks to increase pass-through rates to avoid net deposit outflows. Customer deposits have grown in recent years, and low-interest rates meant most inflows were into sight deposits rather than remunerated savings deposits. Sight deposits are more prone to withdrawals as interest rates rise, but banks have limited the associated liquidity risk by not investing the deposits in long-duration assets.
Funding stability is also supported by longer-term funding in the wholesale markets, which has been incentivised in the EU and the UK by minimum requirements for own funds and eligible liabilities. In addition, covered bond funding for banks with eligible assets has been reliable even in periods of market stress.
EU and UK banks have access to funding from the ECB and the Bank of England, respectively, in the normal course of business, and Swiss banks have access to the SNB. This is an important mitigant for market confidence stresses. The need for banks with large trading operations to fund their trading assets and manage collateral requirements on a daily basis across legal entities in different jurisdictions and currencies adds challenges, but the increased frequency of US dollar liquidity provision by several central banks outside the US should ease the pressures.